Time to stay safe

NSE Nifty may drift towards 5,000 levels on falling market multiples and earnings downgrades.

August 13, 2013 10:35 IST | India Infoline News Service
Since 2008, the Indian bourses have been plagued by a litany of upheavals—be it the subprime crisis, Euro crisis, the Chinese slowdown or the recent rupee tumble. The fear of a bond buying pullout by the Fed has led to US bond yields and currency strengthening against many others. In India’s case, the erosion in the rupee’s value was severe owing to its gigantic current account deficit (CAD), the third largest in the world in absolute terms, after the US and Britain. As a percentage of the GDP, India’s CAD stands higher than both these countries.

Obviously, our stock market fears a sudden flight of foreign capital that India desperately needs to finance its colossal deficit. Already, FIIs have pulled out more than $5 billion in the previous two months. The reluctant government initiative to open the FDI gates seems an unlikely remedy. A few patterns are getting more evident than others.

First, that the dollar is bound to strengthen further. The euro-region is still not out of the woods but the US data has shown signs of improvement and QE3 is likely to taper off as early as next year. Second, India’s attractiveness as an investment destination has taken a beating, thanks to our political disorder, lack of concrete reforms, made worse by the retrograde steps to tax MNCs. Third,
our pace of growth has taken a telling blow and there’s neither clue nor clarity as to when the trajectory would change for the better.

The governmental steps to reduce the CAD have not yielded the desired results. Although oil prices have not moved up much in dollar terms, the glaring rupee depreciation has bloated the import bill. That’s precisely why the under-recovery on diesel has been rising in the last few months, in spite of the diesel decontrol. Although authorised gold imports have fallen after the import duty hike, the rise in smuggling may have made up for the official fall. How will one regain investor trust or dissuade him from investing in gold when his confidence is dented by the sudden erosion of his capital in an exchange-designed product like spot commodity arbitrage?

With a new RBI governor at the helm, one does hope for a rate cut or, at least, one expects no further hikes as feared in the wake of the recent RBI measures to save the rupee. But it would be unfair to expect miracles, especially given the gravity of the problems that he inherits. The depreciating rupee is bound to keep consumer inflation elevated as seen in the previous data release. If the rupee touches 63-64, even the new governor will be left with no choice but to raise the CRR. Needless to say, it won’t spell good news for the market.

The food security programme motivated by populist drives is a serious threat to the fiscal deficit. Already, the economy is reeling under the impact of a cut in Plan expenditure to contain fiscal deficit to the figure of the previous budget. Now any spending on food close to the election time will make matters worse for a fiscal deficit that is already hard to achieve, thanks to over-optimistic revenue assumptions and understated non-Plan expenditure.

As a direct consequence of the economic gloom, most industries are feeling the pinch, whether in manufacturing or services. Auto sales have hit new lows, their worst phase in the last two decades. Falling retail sales and dwindling domestic travel indicate a slowdown in consumption. Corporates are averse to new investments given that they are already highly leveraged and low in confidence and capacity utilisations. Infrastructure development has not shown any signs of pick up. The critical areas of land acquisition, environment clearance, DTC, GST and labour laws are still deprived of the much-needed reforms. I don’t foresee any progress on this front before the elections and even after that, it would take a stable government at the Centre to push these non-populist reforms to fruition.

Given the overwhelming negatives of the current environment, we are staring at a sub-5% GDP growth this year and probably the next. Corporate earnings and valuations reflect this gloom in good measure. The last quarter witnessed one of the worst earnings growth phase after FY07. This quarter is likely to follow suit. Revenues of some 135-odd companies have grown by merely 5% y-o-y and their profits are noticeably flat. If one excludes the high component of the other income of some companies like Reliance, then the profitability picture is worse than it looks. The forex losses consequent to a sliding rupee will also cause excruciating pain for many companies. Sub-14x FY14 valuations also reflect the poor sentiment. The sizeable supply of equities on account of disinvestment and offer for sale (OFS) is likely to act as an overhang on valuations.

Clearly, the going is tough and to believe that the tough would get going is tougher than what the popular proverbial phrase emphatically suggests. Most companies in the Nifty are trading below their 2008 lows. Only a handful of sectors like FMCG, IT and Pharma have held their fort in the market and now even these are cracking due to indefensible valuations. I expect Nifty to drift lower to 5,000 levels, the basis being falling market multiples and earnings downgrades.

This is the time to stay safe, not merely stay put. Fixed income instruments could hence be a prudent investment option. But these days, one can argue that even fixed income has turned a fluctuating income. ‘Cash is king’ mantra is beginning to emerge in investment circles. I am keenly awaiting a few more kings to emerge from the mists out of nowhere.

The article was first appeared in The Financial Express dated August 12, 2013

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